In an effort to protect taxpayers, hold corporate wrongdoers accountable, and deter future fraud and abuse, U.S. Senators Jack Reed (D-RI) and Chuck Grassley (R-IA) are introducing legislation to rescind tax write-offs for illegal corporate behavior. The bipartisan Government Settlement Transparency & Reform Act would close a loophole that has allowed some corporations to reap tax benefits from payments made at government direction stemming from settling misdeeds.

Corporations accused of illegal activity routinely settle legal disputes with the government out of court because it allows both the company and the government to avoid the time, expense, and uncertainty of going to trial.

Federal law prohibits companies from deducting public fines and penalties from their taxable income. But under current law, offending companies may often write off any portion of a settlement that is not paid directly to the government as a penalty or fine for violation of the law. This allows some companies to lower their tax bill by claiming settlement payments to non-federal entities as tax deductible business expenses.

The Reed-Grassley bill would require the government and the settling party to reach pre-filing agreements on how the settlement payments should be treated for tax purposes. The bill clarifies the rules about what settlement payments are punitive and therefore non-deductible and increases transparency by requiring the government to file a return at the time of settlement to accurately reflect the tax treatment of the amounts that will be paid by the offending party.

“A penalty is supposed to deter others because it causes pain to a company’s bottom line. If a company is paying thousands, millions, or even billions in fines, it shouldn’t save money for those same misdeeds, it should be held accountable. The law needs to change to ensure the punishment fits the crime. Congress needs to close this settlement loophole,” said Reed.

“A penalty should be meaningful or it won’t have the deterrent effect it’s supposed to have,” Grassley said. “This issue comes up regularly, and this bill would make deductibility clear going forward.”

The bill would amend the tax code to deny tax deductions for certain fines, penalties, and other amounts related to a violation or investigation or inquiry into the potential violation of any law.

It amends subsection (f) of Section 162 of the Internal Revenue Code. Amounts paid by corporations, which constitute restitution for damage caused by the violation of any law are exempted and remain deductible. This section requires that nongovernmental entities which exercise self-regulatory powers be treated as government entities for purposes of disallowing deductions under this section. The bill requires the government to stipulate the tax treatment of the settlement agreement.